Securing Income: Why Dividend Growth Matters

Source: Thinkstock
Source: Thinkstock

Investors have long debated the pros and cons in investing in dividend-paying stocks. Naysayers will argue that money that is paid out to shareholders is money that the company isn’t using to grow its business, and therefore investors should look for companies that don’t pay dividends and instead reinvest profits into their businesses.

This strategy has worked. The most obvious example is Warren Buffett’s Berkshire Hathaway (NYSE:BRK.B), which doesn’t pay a dividend, yet which has grown into one of the largest companies in the world through prudent profit reinvestment. There are similar examples that are less well-known. Take Seaboard Corporation (NYSEMKT:SEB). The company has paid a dividend in the past but it was minimal—just $3/share per year for a nearly $3,000/share stock. Yet the company has generated a 25,000 percent return since 1978.

These are ideal situations, however, and investors shouldn’t always count on picking the next Berkshire Hathaway or the next Seaboard. They are few and far between.

Dividends are a way for investors to gauge the quality of an investment for the long term. Companies that have been paying dividends over a long period of time have demonstrated that they can remain profitable even through recessions, and that they can adapt to a changing business environment.

But of these companies, I think investors should look at dividend raisers. Companies that raise their dividends regularly have proven not only that they can generate profits through both good and bad times, but that they can grow their profits over long periods of time. If you are a long-term investor like me, then this is the sort of situation you should be looking for.

Companies that raise their dividends regularly usually have a couple things in common. First, they operate in industries in which they are dominant, or in which they don’t face significant competition. Proctor and Gamble (NYSE:PG)—one of the world’s most consistent dividend raisers—is such a company. It dominates the consumer products space, which is a stable business. It is for this reason that the company has been able to continually raise its dividend.

Second, they are financially prudent. They don’t pay out too high of a dividend because that would mean that they wouldn’t have room to raise it in the event of a recession. Serial dividend raisers typically pay between 25 percent and 40 percent of their profits out in the form of a dividend. This often means that they have lower dividends today, but if you are forward thinking then you will be able to see how your cumulative dividends over the long run will end up being higher than the dividends paid out by companies with higher dividends, but which don’t raise them as frequently.

With this in mind, you now have a playbook for finding dividend growers. The best place to start looking is the dividend aristocrats list, which is a list of companies that have increased their dividends every year for the past twenty-five years. This list is available on the internet and it includes various well-known companies such as Exxon Mobil (NYSE:XOM), 3M Corp. (NYSE:MMM), and Coca Cola (NYSE:KO). It also consists of some smaller names that fly under the radar, but which may offer greater opportunity precisely because of this.

You should also consider looking at the dividend achievers, which have raised their dividends for five years running. However, I would look specifically at companies that are close to joining the aristocrats, as five years simply isn’t a long enough track record for long term investors, many of which are putting money into stocks today that they hope to hold for decades. Still, we can see companies on this list that we can guess will be dividend aristocrats in the future. Visa (NYSE:V), which has only been publicly traded for six years is one of these companies. Its dividend is small, but it is growing, and the company fits the above criteria for quality dividend stocks.

Disclosure: Ben Kramer-Miller is long Exxon Mobil and Visa.

Want more great content like this? Sign up here to receive the best of Cheat Sheet delivered daily. No spam; just tailored content straight to your inbox.